The article “There’s More To The RRSP Than Mutual Funds and ETFs, But You Have To Tread Cautiously” was originally published on Financial Post on February 17, 2017.
At this time of year, we are bombarded by marketing to buy the same RRSP investments we have always purchased in the past. For most Canadians, the investment of choice is a mutual fund, though exchange-traded funds (ETFs) are playing a bigger role for both do-it-yourself investors and investment advisers.
The last Statistics Canada Survey of Financial Security that looked at RRSP investments was in 2005. At that time, mutual funds topped the list at 37 per cent of RRSP assets. According to the Investment Funds Institute of Canada (IFIC), mutual funds represented 31 per cent of overall Canadian financial wealth as of 2015, so it is clear they still dominate the RRSP market.
Some of the more common RRSP investments beyond mutual funds include cash, guaranteed investment certificates (GICs), stocks, bonds and ETFs.
But while most Canadians stay with this more conservative group of investments, they aren’t the only options out there. Here’s a look at a few more that can be considered.
Canadians might be surprised that foreign currencies are qualified RRSP investments, but not all currencies fit the bill. According to the Canada Revenue Agency (CRA), “digital currencies, such as Bitcoins, are not considered to be money issued by a government of a country and are not qualified investments.” At least not yet.
My concern with currencies is that they do not produce an income. Profiting from converting back and forth between currencies is not easy for investors.
Historically, some Canadians have held their mortgage in their RRSP, but the strategy is much less appealing these days. Effectively, you are borrowing some of your RRSP savings from yourself as a mortgage. The applicable interest rate is the posted rate, however. So you may be borrowing from yourself at a lofty 5 per cent, but also earning a decent return of 5 per cent on your RRSP as a result.
Although it may sound good on the surface, with both fixed and variable interest rates near historic lows, I do not much like this strategy right now. I would rather borrow from the bank at 2.5 per cent on my mortgage and invest my RRSP at a higher return, thereby making money on the spread between those percentages. Furthermore, holding your mortgage in your RRSP results in additional administrative costs and few institutions allow mortgages in your RRSP, anyway.
Foreign stocks, including those trading on designated stock exchanges, are also qualified RRSP investments. The list of designated exchanges is quite extensive. There are 41 exchanges outside of Canada that qualify, though 11 are U.S. exchanges. The challenge is finding a financial institution that allows you to buy foreign securities in your RRSP, as not all will let you do so.
Canadian mutual funds that invest in foreign stocks, ETFs that track foreign exchanges and American Depositary Receipts (ADRs) of foreign stocks that trade on U.S. markets all provide foreign investment options that could suffice for most investors.
Precious metals may have lost some of their luster in the past five years, but can still be held in your RRSP in various forms. Gold and silver bullion, coins, bars and certificates may be qualified RRSP investments, subject to certain purity and other conditions.
Some investors feel strongly that a portfolio should include an allocation to gold. A 2005 Ibbotson Associates study found that gold exhibited the most negative correlation to traditional financial assets from 1971 to 2004. It could, therefore, be a good hedge or portfolio diversification tool.
Warren Buffett disagrees. He once said: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
Some private company investments can be held in your RRSP. In order to qualify, the broad rules are that the investment must be in a specified small business corporation that is Canadian, controlled by Canadians, engaged in an active business carried on in Canada and you cannot own more than 10 per cent of the company. This list is a simplification of complex rules so ensure you get professional advice before considering this for your RRSP.
Should you buy private company shares in your RRSP? I would argue that you would be better off buying them in another account. If you hit a home run, your RRSP could rise significantly in value and be a ticking tax time bomb when you have to start your RRSP withdrawals in retirement.
A Tax-Free Savings Account (TFSA) may be a better place to turn a dollar into ten.
But the lifetime capital gains exemption of $824,176 on qualified small business corporation shares also provides a tax exemption on capital gains outside a registered account. And if your investment goes bust, which happens more often with private than public companies, the Allowable Business Investment Loss (ABIL) rules may allow you to claim a deduction against your other income and get a tax refund outside a registered account. If an investment goes to zero in your RRSP, there is no recourse.
Another class of creative RRSP investments is call options or put options. A stock option is a type of security that gives you the right to buy or sell a stock at a pre-determined price. So a stock option is not a stock, but simply, a contract to buy or sell a stock.
If you buy a call option, you are buying the opportunity to buy a stock at a certain price, say, $50. If the stock trades at $45 now and suddenly goes to $55, that $50 call option has a value. The owner of the option can buy a stock worth $55 for only $50, thereby making a profit.
A put option works similarly but in reverse. If you buy a put option, you have the right to sell a stock at a certain price. If the option is a right to sell at $50 and a stock trades at $55 but drops to $45, that put option has value because you can sell something for $50 that is worth now only worth $45.
You can buy an option or you can write (sell) an option. RRSP investors can buy or sell call options, but call options can only be sold (written) if you already own the underlying shares in your RRSP (called a covered call option).
Option writing strategies that are deemed by the CRA to be speculative could be a problem. CRA could decide that an RRSP is carrying on a “business” and earning taxable “business income.”
“The CRA’s view is that the writing of a covered call option, whereby a registered plan sells a call option in respect of an underlying property which it already owns, does not result, in and of itself, in the registered plan being considered to be carrying on a business. In contrast, the writing of an uncovered call option, or the writing of a put option … may result in the registered plan being considered to be carrying on a business.”
Option investors should proceed with caution generally, as these are complex investments. Investors should be that much more careful trading options in an RRSP due to the potential adverse tax consequences.
Last, but not least, RRSP investors may not know that they can buy an annuity with their RRSP savings. Annuities tend to be more synonymous with Registered Retirement Income Funds (RRIFs) and the drawdown phase of your registered savings. But deferred annuities can be purchased today to start making payments to you in the future from your retirement savings.
Personally, I would be a bit leery to buy a deferred annuity today when interest rates are so low and likely to rise in the medium term before payments start. Higher interest rates mean higher annuity monthly payments. I also like the flexibility of deciding how to draw down your retirement assets when you are ready to retire as opposed to doing so now in advance. So while annuities may be a viable RRIF strategy for some retirees, I am not keen on a deferred annuity as an RRSP investment option.
In summary, there are lots of unique RRSP investment options available to investors beyond mutual funds. I think most people should stick with the plain vanilla options like GICs, bonds, stocks and ETFs rather than venturing into the murky waters of alternative RRSP investments, particularly given there are so many options even within that plain vanilla group.
For those more adventurous RRSP investors, consider some of the above RRSP investments that you may not have otherwise known about before.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.